A recent AFR article reminded me once again about how ASX LIC performance fees are a very nice deal for the fund managers. The article quite rightly posed questions about how they are free to choose whatever benchmark they like. Then why they sometimes are rewarded substantially when the shareholders go backwards, and why there is no standardised format to present what their performance numbers actually are.

In fact it, is due to the issue of ASX LICs choosing all sorts of variations in performance reporting methods that I wanted to explore some LICs in particular. Have they earnt performance fees way out of line with the results they have achieved?

The ASX LICs in the title are some names that have proved popular with investors at times. Issues such as strange benchmarks and reporting of performance numbers are often raised with these LICs.

When you read the performance figures of a LIC in announcements like monthly NTA reports, they are often designed by the fund manager to paint themselves in the best light.

I always like to visit the annual reports of LICs, or all companies for that matter. With that in mind, I was curious the amounts of performance fees that would show up, compared with how the manager had performed in the volatile period over the last couple of years. This might indicate some of the effects that “high water marks” and “strange” benchmarks or performance hurdles can have.

By the way here are some of the recent AFR articles that triggered my curiosity.

Fundies’ fee bonanza throws up many questions (afr.com)

Thorney’s questionable performance fees (afr.com)

Some of the ASX LIC managers that are covered here include L1 Long Short Fund Ltd (ASX:LSF), Thorney Opportunities Ltd (ASX:TOP), WAM Capital Limited (ASX:WAM) & VGI Partners Global Investments Ltd (ASX:VG1).

The main point here is to try and describe a bit more about how some of these performance fee structures work. That hopefully achieves more of a balance of information that an investor can find when searching on this topic. Without this, there are tons of other articles from promoting the IPO, to the manager’s own versions of performance reporting, to fund manager “puff” pieces that tell you everything you can imagine but conveniently are silent on performance fees, benchmarks, and high-water mark clauses etc.

Comparison of various ASX LIC performance fees

L1 Long Short Fund Ltd (ASX:LSF) Performance Fees review

• L1 Capital gets 20% (plus GST) of the return of the portfolio.
• If the return of the portfolio happens to have underperformed a common benchmark such as the ASX200 Accumulation index that doesn’t matter, a performance fee can still be generated.
• They do measure portfolio returns (for performance fee calculation purposes) after the accrual of management fees.
• There is some sort of “high water mark” feature.
• The high water mark that kicks in is the portfolio value adjusted for the performance fee paid, that was set when the company last generated the performance fee.

My Comment on L1 Capital performance fees – Getting paid 20% on all positive returns is extremely generous. I suppose you could say at least they have to claw back any negative returns to start earning performance fees in the future again if that occurs. So they are not the worst out there (we shall get to that later).

It is interesting that this scenario actually kicked in because of the poor start as a LIC by LSF. That at least meant not as bad a fee drag when they bounced back. There was also an advantage about 18 months ago as they had some tax losses to utilize.

Their unlisted version of this product has generated strong returns even after allowing for a similarly high fee structure. It is possible the recent performance bounce could provide a stronger dividend policy soon (after all the directors are getting close soon to filling up their boots with shares again?).

I know they have the runs on the board in achieving returns on a large base of AUMs despite charging high fees, I am just a bit skeptical how sustainable it is longer term from here. I would be interested if readers have any other examples of fund managers with quite large AUMs but charging a 20% performance fee on any positive return, that keep delivering good results for their investors over the very long run?

Thorney Opportunities Ltd (ASX:TOP) Performance Fees review

• Thorney Opportunities gets 20% of the positive return achieved of the portfolio.
• If the return of the portfolio happens to have underperformed a common benchmark such as the ASX200 Accumulation index that doesn’t matter, a performance fee can still be generated.
• They do measure portfolio returns (for performance fee calculation purposes) after the accrual of management fees.
• No high watermark.

My Comment on Thorney Opportunities performance fees – No high watermark and no real benchmark to which the apply the 20% performance fee is worse than LSF above. Unfortunately for shareholders this combination delivered an extremely favorable outcome to the fund manager, and poor results to shareholders.

This was highlighted in one of those AFR articles I linked to above. TOP portfolio declined in 2020, but they enjoyed juicy performance fees just because the portfolio had a bounce from June 30 to December 31.

The strange performance fee methodology of allowing the performance fee hurdle to get reset every year was highlighted in this article also.

Peak to peak, which LIC managers performed during COVID? (firstlinks.com.au)

This publicity surrounds events over the last couple of years, how do they stack up longer term though? After all, with LSF I mentioned how they still manage to deliver alpha after fees to their investors. Is TOP also a case of the investors still getting above market performance even after the hefty fees?

Like many LICs, I wish you luck even finding their version of what the long-term performance numbers are. My experience usually as a rule of thumb is, if the LIC can spin a story that there might be some alpha, it will get displayed in some sort of form regularly to the market. Performance tables will be easy to locate.

Of course often investors can judge a manager harshly over a period where their style is not that fashionable, so maybe we should give TOP some more years before we judge?

I sometimes wonder if an investor is likely to get better returns if they simply try and take a copycat approach in replicating the TOP portfolio? Obviously this will be far from a perfect replication and you could do worse. However given the relatively infrequent turnover of the TOP approach, and the big head start you get from avoiding the massive fee drag, you might be in with a fighting chance of doing much better.

Perhaps there is an argument here that the fund manager has delivered plenty of alpha after hefty fees back in the older days of investing within private structures. Certainly there is plenty of articles online about a great reputation as an investor. However there is not much transparency in terms of what the fund manager achieved in terms of the pre Thorney LIC days and what AUMs this was based on.

WAM Capital Limited (ASX:WAM) Performance Fees review

• WAM Capital gets 20% (plus GST) of the return of the portfolio that exceeds the All Ords Accumulation Index. This is paid annually, in arrears.
• If the All Ords Accumulation Index has a negative year, WAM Capital gets the 20% (plus GST) on the amount the portfolio increased over the period.
• If WAM Capital has a negative year a performance fee cannot be earned.
• No need for them to claw back previous years of underperforming the benchmark.

My Comment on WAM Capital performance fees – The benchmark of the ASX All Ords Accumulation index is at least better than some others here that I discuss. However the absence of any sort of high watermark feature where they need to claw back previous underperformance is a problem. In theory a scenario exists where WAM Capital could achieve substantial underperformance to their benchmark in many consecutive years. Then they bounce back and have a mildly good year vs the index and straight away earn “performance” fees. For example, year 1, 2 & 3 say they underperform the index by a whopping 10% each year, say they grow the portfolio 2% every year but the All Ords is doing 12% a year. Then in year 4 WAM manage to grow the portfolio by 10% whilst the All Ords only does 5%. WAM would get a nice performance fee in year 4 despite being way behind the index cumulatively over such a period.

I have commented in the past about the large premium WAM Capital shares often trad at, so I shall try and not go over old ground again there. I would also add though the performance fee structure is less than ideal.

To WAM’s credit though, historically they have justified to some extent the performance fees they have. However “historically” is the key term here. It doesn’t get easier to outperform when your AUMs have increased faster than the market and you are managing a growing pile in the billions.

Despite my comments just above the WAM funds did do an ok job over the last couple of years with performance, navigating the volatile period pre and post covid-19.

When looking back over the last decade, and taking away some of the performance leakage from base management fees, other costs and performance fees the alpha looks fairly marginal. Over the last 5 years it might have been better to just own an index ETF. I get why some older shareholders who were there from day 1 of inception in 1999 might still stick around though. The sweet spot was in their first decade when they were small enough to play around and be nimble in small / microcaps.

As an aside, I thought their latest LIC in WAM Strategic Value Ltd (ASX:WAR), said a lot about how they set their performance fees at times. In that case they followed the approach used by L1 Long Short Fund Ltd (ASX:LSF). I discussed this in a recent blog post on a review of WAM Strategic Value Ltd (ASX:WAR) here:

WAM STRATEGIC VALUE

WHICH LICs WILL WAM GO TO WAR ON? WAM STRATEGIC VALUE REVIEW (ASX:WAR) – Value Investing for a living.

VGI Partners Global Investments Ltd (ASX:VG1) Performance Fees review

• VGI Partners Global gets 15% (plus GST) of the return of the portfolio.
• If the return of the portfolio happens to have underperformed a common benchmark such as the ASX200 Accumulation index that doesn’t matter, a performance fee can still be generated.
• They do measure portfolio returns (for performance fee calculation purposes) after the accrual of management fees.
• There is some sort of “high water mark” feature.
• The high water mark that kicks in is the portfolio value adjusted for the performance fee paid, that was set when the company last generated the performance fee.

My Comment on VGI Partners Global Investments performance fees – A similar structure here to what was noted with LSF above, although not as bad in this case where the performance fee is 15% as opposed to 20%.

Still extremely high by industry standards in the context of being charged on any positive portfolio returns, irrespective of what common global equity indices might deliver.

The manager here has a strong record after fees going by their published unlisted fund’s performance tables going back some 12 years or so.

Perhaps this can be another case like LSF, where the manager just had a lean run for while after its LIC IPO? Are we seeing managers like this having a flat spot in part because they are taking on much larger AUMs aggressively raising capital, and does this prove to be a distraction to their stock picking focus?

I suppose it wouldn’t shock me if they eventually close the discount to NTA. Activists have applied some pressure and the board has at least followed through with some initiatives. These include a serious share buyback, strong dividend intentions, efforts on shareholder communications, and they have a performance fee reinvestment scheme. Still looking at the recent performance record it might require patience.

Are ASX LIC performance fees worth it?

Let me know in the comments if you think all of these LICs above can clearly beat the market after fees well into the future?